Question
There are two key divisions in a major international organisation. Division Y makes the small component and Division Z makes the finished product, which incorporates
There are two key divisions in a major international organisation. Division Y makes the small component and Division Z makes the finished product, which incorporates one small component. Division Z normally purchases the small component from Division Y.
Details of the selling prices and costs for each product are:
| Small component | Finished product |
Selling Price | 66 | 106 |
Direct materials | 19 | 10 |
Transfer price from Y | - | 66 |
Direct labour @ 2 per hour | 10 | 6 |
Variable overhead | 5 | 4 |
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Divisional Fixed Overheads | 950,000 | 490,000 |
Outside sales (units) | 100,000 | 25,000 |
Divisional investment | 13,600,000 | 2,550,000 |
Division Z currently has a return on investment below the head office target of 15%. The transfer price of the small component is set at a competitive market price of 66.
After receiving an appeal from the Manager of Division Z to intervene, the Chief Executive asks you to consider a proposal for a two-part tariff transfer price system.
You are required to:
- Advise the Chief Executive on the appropriateness of the present transfer price system, with supporting calculations of its effects on the respective profitability and returns of each division.
(8 marks)
- To recommend a basis for the two-part tariff transfer price system, with supporting calculations and comment on its impact on the two divisions.
(9 marks)
- Comment on why you think the Chief Executive may be reluctant to intervene.
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